Turkish Lira: Well-known weaknesses come back into focus

 

After a relatively calm period around the Turkish Lira in the past few weeks, with the USD-TRY remaining stable around 6.85 TRY, this calm has suddenly ended. For the first time since mid-May, the currency pair has left the 7.00 TRY mark and currently even the historically weak quotations from May behind. This movement is all the more remarkable as the US dollar is currently in a difficult position itself – especially compared to the situation in May – and illustrates the prevailing pressure on the lira. However, the existing domestic problems are by no means new. In spite of the relatively stable development in June and July, we had classified the constellation for the lira as fragile, as Turkey basically offers sufficient scope for attack with an economy sliding deep into recession, a clearly rising budget and current account deficit and an expansive monetary policy course of the Turkish central bank, irrespective of the observed inflation trend. Added to this is the weak external liquidity position in combination with low foreign exchange reserves and unorthodox political leadership.

President Erdogan is constantly opening up new (foreign-policy) trouble spots, ranging from interventions in Iraq and Syria to the natural gas dispute in the Mediterranean and the recently completed conversion of the Hagia Sophia into a mosque. And political influence has also increased within its own borders. Any criticism of the policies of the president and his government is not welcome; democracy and human and civil rights have suffered noticeably since the attempted coup in 2016. Current developments show that market participants seem less and less willing to tolerate this.
In addition, as in May, the focus is again shifting to Turkey’s weak external liquidity position and thus also the question of the adequacy of Turkey’s currency reserves. As a guide, it is worth taking a look at the ratio of short-term external liabilities to foreign exchange reserves. Here, a level of at least 1 (short-term liabilities can be fully covered by foreign exchange reserves) appears to be a plausible value to strive for. The only problem is that Turkey is far from this level and the foreign exchange reserves are not sufficient to cover the external debt declared as short-term. On the contrary, Turkey’s reserves have declined significantly in the course of the year to date. An expansion of an existing currency swap line agreed with Qatar by USD 10 bn only caused a short-term increase. Against this background, Turkey is dependent on foreign capital inflows. Of course, it is not helpful that the corona crisis has also hit tourism hard, so little support can be expected from this side. On the market side, there are – unsurprisingly – increasing calls for interest rate hikes to support the lira, but this is unlikely to be desirable from either a political or an economic point of view.

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